Updated Mar 21, What is an Index Option? No actual stocks are bought or sold.
Index options are always cash-settledand are typically European-style optionsmeaning they settle only on the date of maturity. Basics of an Index Option Index call and put options are popular tools used to trade the general direction of an underlying index while putting very little capital at risk.
The profit potential for index call options is unlimited, while the risk is limited to the premium paid for the option. For index put options, the non- deliverable index option is also limited to the premium paid, while the potential profit is capped at the index level, less the premium paid, as the index can never go below zero.
Beyond potentially profiting from general index level movements, index options can be used to diversify a portfolio when an investor is unwilling to invest directly in the index's underlying stocks. Index options can also be used to hedge specific risks in non- deliverable index option portfolio. American-style options can be exercised at any time before expiry, while European-style options can be exercised only on the expiration date.
Key Takeaways Index options are options to buy or sell the value of an underlying index.
Index options have downside that is limited to the amount of premium paid and upside that is unlimited. Assume an investor decides to purchase a call option on Index X with a strike price of With index options, the contract has a multiplier that determines the overall price.
Usually the multiplier is It is important to note the underlying asset in this contract is not any individual stock or set of stocks, but rather the cash level of the index adjusted by the multiplier.
The break-even point of an index call option trade is the strike price plus the premium paid. In this example, that isor plus At any level abovethis particular trade becomes profitable. Compare Accounts.